Commodities futures speculation in China brings risks

By Yi Xianrong Source:Global Times Published: 2016-5-3 23:23:01

Illustration: Peter C. Espina/GT



China's financial sector appears to be no less chaotic this year than last year, when there was a sudden crash in stock markets and capital flight caused by volatility in the yuan exchange rate. From the beginning of this year, home prices in some first-tier cities shot up, and the rampant price gains quickly spread to second-tier cities. Although the surge in home prices has pushed up GDP growth temporarily, the growing property bubble risks creating even greater uncertainty for China's economy and financial market. As the speculators smell signs of a government crackdown in the property market, capital has begun flowing to commodities futures markets.

There is currently nearly 30 trillion yuan ($4.6 trillion yuan) of capital floating in the Chinese market. Wherever there is a chance for speculation, the capital will flow to that area. This is currently happening in China's commodities futures markets where speculative bubbles are building up. If the practice is not curbed, the result will be similar to last year's boom and bust in China's stock markets.            

In the past month, hedge funds and other speculators have piled up bets on futures, throwing money into everything from iron ore and rebar to wheat, cotton and even eggs, driving up prices. Take rebar, a steel product used in construction. The trading volume for the most-traded rebar contract in Shanghai hit a record high of 1.4 billion tons in April, while prices climbed more than 20 percent in the month, according to Reuters' estimate. Prices of rebar and raw materials such as iron ore and coking coal dropped Tuesday after the securities regulator urged major Chinese commodity futures exchanges to rein in speculative trading on Friday, but industrial insiders believe there is still potential for prices to rise again.

Some observers attributed the spike in commodity prices in the past month to a recovery in the property market and the launch of new infrastructure projects. But this is actually an excuse for rising speculation in commodities futures markets. If investors are optimistic about China's real economy, why don't they invest in stock markets instead of commodities futures? Besides, many firms and industries related to commodities futures are already burdened with overcapacity. Since these firms and industries cannot even digest the existing capacity, how can they be expected to increase output to meet future demand?

Furthermore, a recovery in the real economy would be first reflected in the stock market. However, the Shanghai Composite Index dropped 2.18 percent month-on-month in April. The risks in the stock market are lower than in the commodities futures market because the leverage in the futures market is greater, and it could force investors into bankruptcy if they invest in the wrong commodities futures.

Others believe that the reason why domestic retail investors or speculators are keen on speculating in the property market and commodities futures is that they have a lot of extra money and there are no other good investment channels in China. For example, they believe that after the stock market crash in 2015, retail investors began to pour money into the property market, bonds and commodities futures markets. According to statistics from financial data provider Wind, positions in commodities futures rose from less than 700 billion yuan to around 1.25 trillion yuan from June 2015 to the end of April this year. According to media reports, floating capital from coastal province Zhejiang is the major player in the commodities futures markets.               

However, this belief is also a fallacy. A large portion of funds that are used to speculate in either the property market or commodities futures markets come from borrowings from banks and financial markets. Many speculators do not want to pay the down payment with their own money and would rather borrow from the financial markets. It would be absurd to conclude that the funds that have flowed into the property market, bonds and commodities futures markets are mainly from residents who can find no other promising investment channels. Price spikes in property and commodities futures are actually a result of the Chinese version of quantitative easing that has been practiced in recent months.

In order to reduce financing costs and reduce property inventories, the authorities have injected a large amount of money into the market. Investors quickly spotted the opportunities and sought every possible means to use the cheap money to speculate in the property and commodities futures markets.  

In China's financial market, which still remains underdeveloped, introducing any forms of derivatives, regardless of commodities futures or stock index futures, will generate limited benefits. But the negative impact on the stability of the financial market will be very serious because these instruments can be easily exploited by speculators for big and quick gains. The recent spikes in commodities futures markets are clear evidence of this. If speculation in commodities futures markets continues, the result will be a boom followed by a sharp crash and China's financial market will be mired in chaos again, a scenario that Chinese policymakers should take measures to avoid. 

The author is a professor with the College of Economics at Qingdao University. bizopinion@globaltimes.com.cn



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